Buying Stock = Owning Future Earnings

What is the reason for buying a business?
Why would someone pay hard-earned dollars for a share of a company?

When you buy a stock, you lay a claim on the future earnings on that stock. You effectively “own” the future earnings of the company. Let’s consider the broad market index today. The S&P 500 companies are expected to earn $70.20 this year. The S&P 500 index closed at 1181.21 today. If someone buys a share of S&P 500 at $1181.21 today, this person is expected to earn $70.20 dollars in 2005 on the $1181.21 investment.

It is widely known that earnings growth for the S&P 500 in last 70-75 years has been around 5%. If earnings grow by 5% in 2006 from 2005 levels, then this S&P 500 stockholder will earn $73.71 in 2006 from the investment. Let’s continue this further: 2007 earnings should be $77.40, 2008 earnings should be $81.27,…………..

The table below lays out the estimated earnings for the next 20 years. Our S&P 500 stockholder owns these earnings as long as she does not sell her stock.

Calendar Year	S&P 500 Expected Annual Earnings	Estimated Fair Market Value
2005	$70.20	1053.00
2006	$73.21	1105.65
2007	$77.40	1160.93
2008	$81.27	1218.98
2009	$85.33	1279.93
2010	$89.59	1343.92
2011	$94.07	1411.12
2012	$98.78	1481.68
2013	$103.72	1555.76
2014	$108.90	1633.55
2015	$114.35	1715.23
2016	$120.07	1800.99
2017	$126.07	1891.04
2018	$132.37	1985.59
2019	$138.99	2084.87
2020	$145.94	2189.11
2021	$153.24	2298.57
2022	$160.90	2413.50
2023	$168.94	2534.17
2024	$177.39	2660.88
Total	$2321.23	-

In the 20th year of her investment (in 2024), she should earn $177.39. As the final total in the above table indicates, her total earnings from her owning this stock for 20 years should be $2321.23.

Let’s suppose at that time, in 2024, our investor decides to sell her stock of S&P 500. Assuming the normal valuations at that time, she should be able to sell her one stock for 15 times the earnings. That is, if S&P 500 stock is expected to earn $177.39 in 2024 then it should sell for $2660.88 ($177.39*15 = $2660.88).

What is the total reward by owning the S&P 500 stock for 20 years?
Total Reward = Total Earnings + (Final Price – Initial Price)
= $2321.23 + ($2660.88 – $1181.21)
= $3800.90

We did not re-invest the earnings in this calculation. If the earnings are re-invested in the stock, then the “Total Reward” should be much higher than $3800.90.